Banks vs. Credit Unions

[Shawn]

Okay, I've always used banks, I have the opportunity to join a credit union...but really don't understand what the difference is...or what the pros and cons are. I know it will differ from place to place...but can somebody provide me with a simple explanation of the difference?

Thanks in advance.

Shawn

[JSngry]

Credit unions are owned by their members. If you have an account, you're a part-owner.

If you find one that's insured, well-managed, and solvent, they're a better deal for the average consumer than are banks. Lower intrest on loans, higher yields on savings, and a friendlier attitude towards "special needs" (within reason, of course). As with banks, the primary objective is to serve the owners. Which with credit union is you.

Of course, this is all a generalization. Some credit unions are little shops of financial horrors. But all things being equal, I've always preferred to use credit unions over banks.

[BeBop]

Credit unions are often able to pay higher rates on deposits and charge lower rates on loans because they are tax-exempt. In a sense, you're already paying for everyone else's credit union use.

They were granted tax-exempt status because they were designed to serve narrow groups of customers - say employees of a single employer, often a public entity, customers who were presumed to have limited access to banks. Unfortunately, they have expanded their membership bounds and now serve broad communities, offer commercial loans and other products - none of which was contemplated when the tax-exempt status was granted. They are also subject to a narrower set of limitations on their activities - fewer constraints. So they compete unfairly against banks. It's not a level playing field.

Personally, I think the playing field should be leveled. Or credit unions should.

[BeBop]

http://www.aba.com/Industry+Issues/Issues_CU_Menu.htm Edited June 12, 2006 by BeBop

[Big Wheel]

Credit unions are often able to pay higher rates on deposits and charge lower rates on loans because they are tax-exempt. In a sense, you're already paying for everyone else's credit union use.

They were granted tax-exempt status because they were designed to serve narrow groups of customers - say employees of a single employer, often a public entity, customers who were presumed to have limited access to banks. Unfortunately, they have expanded their membership bounds and now serve broad communities, offer commercial loans and other products - none of which was contemplated when the tax-exempt status was granted. They are also subject to a narrower set of limitations on their activities - fewer constraints. So they compete unfairly against banks. It's not a level playing field.

Personally, I think the playing field should be leveled. Or credit unions should.

Maybe the playing field is somewhat unfair for a small bank. But I have a hard time believing that the small banks wouldn't be getting gobbled up anyway by the big banks, like they are currently. There's no way that the playing field is unfair for the likes of Wells Fargo, Washington Mutual, and Bank of America.

[Guy Berger]

Personally, I think the playing field should be leveled. Or credit unions should.

Maybe the playing field is somewhat unfair for a small bank. But I have a hard time believing that the small banks wouldn't be getting gobbled up anyway by the big banks, like they are currently. There's no way that the playing field is unfair for the likes of Wells Fargo, Washington Mutual, and Bank of America.

Well, insofar as one is tax exempt and another is not, BeBop is correct.

From an economic standpoint BeBop might be right. The implicit subsidy to credit unions generates economic inefficiencies. On the other hand, in general lower taxes are a good thing. It's uncertain which of these effects predominates.

Guy

Edited June 12, 2006 by Guy

[BeBop]

Maybe the playing field is somewhat unfair for a small bank. But I have a hard time believing that the small banks wouldn't be getting gobbled up anyway by the big banks, like they are currently. There's no way that the playing field is unfair for the likes of Wells Fargo, Washington Mutual, and Bank of America.

Wells Fargo, WAMU and Bank of America all pay taxes. (Would you say that not paying taxes would make a material financial difference in your life? How about if you were Bill Gates?) The banks are also subject to the Community Reinvestment Act (a burdensome piece of legislation if ever there was one) which requires them to provide financial services to everyone, including low and moderate-income communities.

And if you think all credit unions are small, uh uh.

[BeBop]

Banks outperformed credit unions in 72% of states in lending to minorities, women, and low- and moderate-income borrowers.

Source: NCRC (National Community Reinvestment Council)

It's IRS Tax Day: Why Aren't the Mega-Credit Unions Paying Their Taxes?

Washington, D.C. (April 15, 2004) - Today, as more than 227 million Americans dutifully file their income tax forms with the IRS, a rapidly growing number of mega-credit unions will not pay one thin dime in federal tax. These giant bank-like credit unions won't be filing tax returns — despite the fact that their direct competitors, thousands of community banks, will.

The U.S. Treasury will miss $12 billion in tax revenues over the next decade because these billion-dollar nonprofit revenue-makers — many of which serve millions of members across large geographic regions in the United States — won't be paying any federal taxes.

"Today more than 80 mega-credit unions each have $1 billion or more in assets," said Camden R. Fine, president and CEO of the Independent Community Bankers of America. "These institutions often serve wealthy to middle-income members, offer a wide range of sophisticated banking products and services, and compete aggressively against community banks. Yet these same institutions don't pay taxes and don't bear the same heavy regulatory burden as community banks."

A recent Government Accounting Office study found that mega-credit unions are the fastest growing segment of the credit union industry, while they do not have to comply with the same burdensome Community Reinvestment Act regulations that community banks do. It also confirmed other studies that community banks serve more low- and moderate-income households than these large credit unions. Yet community banking remains one of the most highly regulated industries in the country.

[Big Wheel]

Maybe the playing field is somewhat unfair for a small bank. But I have a hard time believing that the small banks wouldn't be getting gobbled up anyway by the big banks, like they are currently. There's no way that the playing field is unfair for the likes of Wells Fargo, Washington Mutual, and Bank of America.

Wells Fargo, WAMU and Bank of America all pay taxes. (Would you say that not paying taxes would make a material financial difference in your life? How about if you were Bill Gates?) The banks are also subject to the Community Reinvestment Act (a burdensome piece of legislation if ever there was one) which requires them to provide financial services to everyone, including low and moderate-income communities.

And if you think all credit unions are small, uh uh.

Of course they all pay taxes - my point is that big banks, like other large businesses, enjoy economies of scale that enable profits over and above the dreams of most smaller institutions. It's not like the tax inequity is really screwing them over.

My point boils down to two words: "that's life." We see all kinds of tax inequities in America, and it seems kind of silly to be complaining about those in the financial industry as if they were particularly insidious.

Low-income people don't pay taxes either; they receive tax credits like the EITC (I'm ignoring consumption taxes and so forth for now). So theoretically the tax "playing field" is favoring the poor's ability to generate income. Should we eliminate the EITC? Public and nonprofit educational institutions don't pay taxes either; should the playing field be leveled so that for-profit ones can "compete fairly"?

Edited June 12, 2006 by Big Wheel

[Big Wheel]

"Today more than 80 mega-credit unions each have $1 billion or more in assets," said Camden R. Fine, president and CEO of the Independent Community Bankers of America. "These institutions often serve wealthy to middle-income members, offer a wide range of sophisticated banking products and services, and compete aggressively against community banks. Yet these same institutions don't pay taxes and don't bear the same heavy regulatory burden as community banks."

I think Camden Fine has made my point for me nicely.

Personally, I bank with a tiny community bank but am considering switching to a mid-sized credit union for convenience's sake. I stay the hell away from big banks.

[Guy Berger]

Of course they all pay taxes - my point is that big banks, like other large businesses, enjoy economies of scale that enable profits over and above the dreams of most smaller institutions. It's not like the tax inequity is really screwing them over.

My point boils down to two words: "that's life." We see all kinds of tax inequities in America, and it seems kind of silly to be complaining about those in the financial industry as if they were particularly insidious.

But it isn't just about the inequity of the taxes. It's also about the potential inefficiencies generated by said inequities.

Guy

[BeBop]

I've already said my piece. But let me throw out this 'counter': if the system is set up to favor credit unions, and you can take advantage of this system legally, and whatever ethical considerations there are don't bother you...why not?

And with that, I'm out of here!

[Big Wheel]

I've already said my piece. But let me throw out this 'counter': if the system is set up to favor credit unions, and you can take advantage of this system legally, and whatever ethical considerations there are don't bother you...why not?

And with that, I'm out of here!

Why don't the ethical considerations really bother me? Because we're not talking about a person or an auto mechanic shop or an indie record store...we're talking about a friggin' bank, for chrissakes! When my local indie record store has nice plush chairs, huge marble floors, and well-attired gentlemen attending to me as they peer down at my CDs from their horned-rimmed glasses like they have at even my little tiny community bank, maybe then I'll start feeling some sympathy for them.

If the "why not" referred to "why haven't you switched yet to the credit union?" there's a very simple answer: I'm lazy.

[Big Wheel]

Of course they all pay taxes - my point is that big banks, like other large businesses, enjoy economies of scale that enable profits over and above the dreams of most smaller institutions. It's not like the tax inequity is really screwing them over.

My point boils down to two words: "that's life." We see all kinds of tax inequities in America, and it seems kind of silly to be complaining about those in the financial industry as if they were particularly insidious.

But it isn't just about the inequity of the taxes. It's also about the potential inefficiencies generated by said inequities.

Guy

I think what I'm trying to say is: sure, inefficiencies are (generally) bad. But the consolidation of the banking industry that we have seen in the US indicates that a system of many small community banks is relatively inefficient anyway, compared to a system of a few banking behemoths. Clearly smaller banks are having trouble competing with the big boys - otherwise why would they be getting swallowed up right and left? Isn't this like the situation with many small coffee shops getting wrecked by Starbucks (which I think is a good thing as long as the workers get paid more and the coffee is better)? Or am I working from a flawed definition of efficiency here?

Edited June 12, 2006 by Big Wheel

[connoisseur series500]

Of course they all pay taxes - my point is that big banks, like other large businesses, enjoy economies of scale that enable profits over and above the dreams of most smaller institutions. It's not like the tax inequity is really screwing them over.

My point boils down to two words: "that's life." We see all kinds of tax inequities in America, and it seems kind of silly to be complaining about those in the financial industry as if they were particularly insidious.

But it isn't just about the inequity of the taxes. It's also about the potential inefficiencies generated by said inequities.

Guy

I think what I'm trying to say is: sure, inefficiencies are (generally) bad. But the consolidation of the banking industry that we have seen in the US indicates that a system of many small community banks is relatively inefficient anyway, compared to a system of a few banking behemoths. Clearly smaller banks are having trouble competing with the big boys - otherwise why would they be getting swallowed up right and left? Isn't this like the situation with many small coffee shops getting wrecked by Starbucks (which I think is a good thing as long as the workers get paid more and the coffee is better)? Or am I working from a flawed definition of efficiency here?

Smaller banks don't necessarily have trouble competing with bigger banks. They get bought because the big banks offer to buy them at prices they can't refuse.

Big banks buy little banks so they can gain a foothold in a community. When faced with the choice between opening a brand new branch or buying an existing one, the latter option proves to be the better way to go.

I don't know if big banks benefit from economies of scale. It's not manufacturing afterall. They make money by applying other departments to their newly-purchased small bank: insurance services, financial investments, trust, private banking, commercial lending, etc. Oftentimes, a big bank is hurt by having too many banking centers near each other; which often happens after they take over smaller banks.

[connoisseur series500]

As far as answering the question as to which is better, banks or credit unions, I would simply respond that the more cogent issue would be to judge each individually and on their own merits. Some banks are better than other banks and better than some credit unions. Some credit unions are better than other credit unions and other banks. Judge by the individual entity, not the genre.

[Chuck Nessa]

Let me say one thing: Shoe box in the back yard.

Where do you live?

[Big Wheel]

I don't know if big banks benefit from economies of scale.

Nothing like some good old-fashioned wonkery to try and answer this question.

[connoisseur series500]

I don't know if big banks benefit from economies of scale.

Nothing like some good old-fashioned wonkery to try and answer this question.

Your source indicates that determination as to whether large banks benefit from economies of scale is mixed; but on the other hand, large credit unions do seem to benefit.

[Guy Berger]

I don't know if big banks benefit from economies of scale. It's not manufacturing afterall. They make money by applying other departments to their newly-purchased small bank: insurance services, financial investments, trust, private banking, commercial lending, etc. Oftentimes, a big bank is hurt by having too many banking centers near each other; which often happens after they take over smaller banks.

The Economist recently had a survey on consolidation in the financial industry:

BORROWING and lending has become a fairly well-understood line of business, and a fairly well-managed one most of the time in most of the world. It is the banks themselves that are volatile, shifting shapes and strategies as furiously as their regulators will allow them in their efforts to win markets and market share. In China they are escaping state captivity by selling shares to foreigners and stockmarket investors. In Russia they are running wild, with balance sheets growing by 30-40% a year. In Japan three new “megabanks” have eaten 11 old banks and are now digesting them. In central Europe foreigners have bought or built 80% of the top local banks since the fall of communism.

In America the ten biggest commercial banks control 49% of the country's banking assets, up from 29% a decade ago. They are pausing for breath now, after a long merger binge encouraged by the deregulation of interstate banking and the removal of barriers between banks, insurance companies and securities firms. Non-financial companies are not meant to own banks, but even that is now being tested by America's biggest retailer, Wal-Mart, which wants a restricted banking licence.

This survey of commercial banking around the world is much preoccupied by questions of size and of ownership. Almost everywhere, big banks have been getting bigger through mergers and acquisitions as well as through organic growth. Is there a natural limit to this process of bank-eat-bank? Could the biggest bank of tomorrow be two or three or even ten times the size of a Citibank or an HSBC today, and if not, why not? And who benefits? It is not always the surviving bank's shareholders. One-half of recent bank mergers around the world have destroyed shareholder value, says Philippe De Backer, a partner in Bain & Co, a consulting firm. In America it is medium-sized banks that are prized most highly by the stockmarkets, partly because investors expect them to be bought dearly by the big banks.

One argument commonly used in favour of mergers, in banking as in many other industries, is the pursuit of economies of scale in areas such as procurement, systems, operations, research and marketing. But the gains from that in the mass production of financial services, though not necessarily illusory, can be elusive. There is a sizeable literature of academic papers claiming that economies of scale can be exhausted by the time a bank reaches a relatively modest size. A study of European banks in the 1990s, published by the European Investment Bank, put the figure for savings banks as low as €600m ($760m) in assets. More recent studies suggest far higher thresholds, up to $25 billion.

Big banks might even dispute that there is a limit at all. But at some point diseconomies of scale will also start creeping in. Management will find it harder and harder to aggregate and summarise everything that is going on in the bank, opening the way to the duplication of expense, the neglect of concealed risks and the failure of internal controls. Something of that last problem afflicted the world's biggest bank holding company, Citigroup, in 2002-05, when it was rocked by a string of compliance problems. America's Federal Reserve reacted by telling Citigroup to suspend large acquisitions, but lifted the order in April this year when it judged that the company had got better controls in place.

Another argument commonly made for mergers is based on economies of scope, the proposition that related lines of business under the same ownership or management can share resources and create opportunities for one another. The basic economy of scope common to almost all banks is the taking of deposits on one hand and the making of loans on the other. The bank gets to re-use its depositors' money profitably. The skills and information useful on one side of the business tend to be useful on the other side too.

But does the same hold good when a retail bank is paired with, say, a corporate bank, an investment-banking division, a credit-card processor, an asset-management operation, private banking (for rich people), an insurance business or a foreign branch network? These businesses all overlap with one another to some degree, but so do lots of other businesses. The fashion for industrial conglomerates came and went 30 years ago. Will financial conglomerates be any more enduring? The bank holding companies that are building them clearly believe so.

A third reason for banks to pursue growth through mergers and acquisitions is one that is never used as an argument at the time, but is universally recognised as a factor. It is managerial ambition (which includes managerial error). Chief executives want the gratification of running a bigger company, or they fear that their own company will be taken over unless they grab another one first.

Managers can argue that the business environment is changing rapidly and that banks must seize the new market opportunities created by new technology or national deregulation or economic globalisation. Thus there is much talk in Europe now of a fresh wave of cross-border mergers and acquisitions within the 25 countries of the European Union, encouraged by the single European currency, the deepening Single European Market and the enlargement of the EU into central and eastern Europe. Shareholders may be the more easily persuaded because a takeover tends to look good at the time. The buyer books the new revenues immediately and cuts some overlapping costs. The acquisition premium goes straight to goodwill. It is only later that you find out whether the businesses are a good long-term fit.

And perhaps growth-hungry CEOs are wiser than their students and their critics know. The very big banks created in America over the past ten years have not been stellar stockmarket performers recently, but they may just be taking time to bed down and knit their management and computer systems more closely together. Their future results may transform the current wisdom about economies of scale.

Bigness may also have benefits not easily captured in studies of financial performance. One is the ability to place strategic bets on future markets, such as China, without putting the whole bank at risk. Another is regulatory capture, or the ability of the regulatee to influence the regulator. The bigger the bank, the more likely its home-country regulators and legislators will be to take its interests into account when drafting new rules, and the more likely they will be to judge it “too big to fail” in the event of a crisis.